Barclays Bank is in the spotlight for submitting its LIBOR fixes to benefit its trading positions. It's not the only major bank to have engaged in the practice. Investigations should soon result in charges being filed against other "too big to fail" banks. Institutions that have said they are being investigated include Citi, JP Morgan Chase, Royal Bank of Scotland, UBS, and Credit Suisse.
The scandal underscores that trading has replaced lending as the lifeblood of banking. The nature of the bank-client relationship has changed. Clients have become counterparties, which translates into "buyer beware". Financial institutions don't have the same fiduciary responsibility to counterparties as they do to customers.
Who takes the losses that offset the traders' gains from manipulating LIBOR? Counterparties to the trades did. Some can be considered sophisticated investors. Several hedge funds and some traders have filed suit on contracts traded through the Chicago Mercantile Exchange. Charles Schwab filed a complaint in 2010.
Others, like cities, relied on the advice of their bankers. Some US cities are suing to recover the losses that artificially low LIBOR rates would have caused. Here's an example of how it works. A city enters into an interest rate swaps based on LIBOR. The bank pays its municipal counterparty a variable payment based on LIBOR. The city pays the bank a fixed payment. If LIBOR is artificially low (because of rate fixing), the city receives a smaller payment. Nassau County's comptroller estimates that the county may have lost US$13 million (on swaps on outstanding bonds with a face value of $600 million) because of rate fixing.
The suits will be very difficult to win. But, banks that are suspected of fixing rates can expect to spend "tens of billions of dollars" on lawsuits, according to a professor at Stanford University.
More importantly, the trust indispensable to well-functioning markets will be further undermined.
The scandal underscores that trading has replaced lending as the lifeblood of banking. The nature of the bank-client relationship has changed. Clients have become counterparties, which translates into "buyer beware". Financial institutions don't have the same fiduciary responsibility to counterparties as they do to customers.
Who takes the losses that offset the traders' gains from manipulating LIBOR? Counterparties to the trades did. Some can be considered sophisticated investors. Several hedge funds and some traders have filed suit on contracts traded through the Chicago Mercantile Exchange. Charles Schwab filed a complaint in 2010.
Others, like cities, relied on the advice of their bankers. Some US cities are suing to recover the losses that artificially low LIBOR rates would have caused. Here's an example of how it works. A city enters into an interest rate swaps based on LIBOR. The bank pays its municipal counterparty a variable payment based on LIBOR. The city pays the bank a fixed payment. If LIBOR is artificially low (because of rate fixing), the city receives a smaller payment. Nassau County's comptroller estimates that the county may have lost US$13 million (on swaps on outstanding bonds with a face value of $600 million) because of rate fixing.
The suits will be very difficult to win. But, banks that are suspected of fixing rates can expect to spend "tens of billions of dollars" on lawsuits, according to a professor at Stanford University.
More importantly, the trust indispensable to well-functioning markets will be further undermined.
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